How to close your next IT outsourcing deal: handshake vs contract

Would you trade your thousand-page outsourcing contract--the one that provides commitment, certainty, and clear-cut requirements and pricing--for a much simpler master services agreement and a handshake with your IT service provider?

Thomas Young, partner at outsourcing consultancy and research firm Information Services Group (ISG), thinks you should.

For years, outsourcing industry experts have likened a successful outsourcing relationship to a happy marriage--one that requires mutual hard work, assurance and respect to last in the long term. But rather than marrying your next outsourcing provider, Young argues, why not take the outsourcer out on a date and see how things go?

"Our current approach to outsourcing contracts is completely out of touch with the needs of a business world," says Young. "We need a new approach where the 'contract' for services is an understanding and a framework rather than a formal document."

Young has been evangelising what he calls "evolutionary contracting", whereby outsourcing customers start with a bare bones contract and adjust the scope and commercial terms of the relationship on an ongoing basis. Young hasn't found any converts yet, but says some clients are considering the approach.

CIO talked to Young about what this kind of outsourcing relationship would look like, what the benefits and drawbacks are, and why his consultant-peers are resisting it.

For years, we've likened outsourcing relationships to long-term marriages. Why is that analogy outdated?

Thomas Young, ISG: When people sign long-term agreements, they're looking for commitment and certainty. Ten years ago, there were relatively static operating models for IT services. But today, certainty is not part of the equation. I can put pricing and terms in place that deliver false certainty, but you will be dissatisfied. The market is so dynamic today that what you need is a flexible arrangement. The commercial terms and protocols need to reflect a level of dynamic change and flexibility.

But you don't want to do away with outsourcing contracts altogether.

Young: No large company will settle for a handshake. But I want people to think differently about contracts. You think of that 1000-page perfect contract that has every contingency laid out. I'd rather have a contract be a handshake and a hundred pages. Those 100 pages represent the master service agreement--all the legal terms around the relationship.

The rest will evolve over time, because there are some aspects you won't have figured out. If you have a structured 1000-page contract that says you need to do something but the situation changes, you'll either have a dissatisfied customer or a provider who can't deliver.

This is what we call "mutual consent" commerce. For this to work well, both of us need to be happy. Both of us need to have our needs met. Both buyer and seller need to be concerned about the success of the counter-party.

How would one of these deals evolve over time?

Young: If we're working together in a dynamic market, I may not even be able to articulate what I want six months or a year from now. Maybe I start with developing a mobile app. But as we start to get customer feedback, the work changes. And as the work changes, the service levels have to change. And as the service levels change, the pricing has to change. So pricing, service-level agreements, and statements of work--the meat of any outsourcing agreement--evolve to meet changing needs.

At the beginning of the contract, you keep it simple. Here's how we'll do things and let's see how it goes. As time goes on, it becomes more sophisticated. Ideally, you move from an input-based metric, where you're paying from a rate card, to output-based pricing for a turnkey solution.

So then, I'm not selecting my provider based on price or service levels then because much of that is to be determined. How would one figure out the best fit with a provider?

Young: In the past, customers used a request for proposal (RFP) process to select a partner. They put a big RFP on a street, invited vendors to reply, and used that process to determine their partner for five to seven years. I wouldn't do that today. I would use a request for solution and pick a service provider based on whether I liked or trusted them or whether I thought they could solve my problem. Then we would build a services framework on that.

That would require much more engagement and management overhead for the customer over the long term.

Young: Historically, what we at ISG and other outsourcing consultancies have anchored our business around is that brokering and transacting of the 1000-page contract. It's episodic, and three to five years later we come back and do it again.

We need to get away from that episodic role and think of the work as continuous with us acting more as a referee or a counsellor in that long-term relationship. You have that documentation around the handshake, and we are that neutral third party to drive communication, make suggestions, and facilitate transparency. That transparency is the hardest hurdle to overcome. Most people don't want to embrace open book outsourcing.

It sounds like a way to drive more billable consulting hours over the life of the outsourcing deal?

Young: We'll move from becoming the higher-price consultants that are episodic to a managed services model at a lower price. We'll only get hired if we continue to provide value.

Senior IT leaders are frustrated with the lack of innovation from their outsourcing relationships. When you get under the covers of that, you find that the way we start these deals is part of the problem. Those 1000 pages choke innovation. If it's 2013 and you're still operating based on a cloud strategy you developed in 2010, what are the chances you got that right? And we're part of that problem.

The bigger these contracts are, the less they are understood. And there's lots of interest on the part of advisors and lawyers to make it more complex. But clients don't want to do that over and over again. Ten years ago, we had total contract values worth $15 billion so a consulting fee of $40 million was irrelevant. As deals shrink, which they have quarter over quarter, the economics of hiring consultants and lawyers doesn't work. We need to simplify that.

What the biggest resistance from customers to this?

Young: I spend a lot of time with financial services customers, and they have a lot of rules. It's hard to get procurement and legal types to adopt this. What I suggest is that it's not either or--it's and. We can try this as an experiment in one or two areas, put business controls in place, have an arrangement that's more informal, and see how it goes.

Providers have built up mature processes around the established method of contracting for IT services. Will they want to change that?

Young: Some will and some won't. It's the nature of anything new. We don't have this all figured out. Those that are interested are excited because this creates a stickier relationship. As you pivot from rate card deals into selling outcomes, they can make a lot better margins--if they do it right.

It's hardest for me to get my partners here in consulting to change. They have gotten comfortable with the way things work. It's human nature.

Could customers just put in place simpler deals that are shorter in duration?

Young: You can do simple and short, but you won't get results if you're in a mode where you constantly churn providers. It will work if you do simpler and shorter deals with the same player--a chain link series of deals.

Are there situations in which this kind of evolutionary contract is a bad idea?

Young: If you're in a situation where you have a well-defined environment and you're just trying to optimize it, a classic RFP approach is called for. Think of payments processing in a bank. That's not likely to change radically in the next five years.

What do your competitors say about this approach? Do they think you're crazy or is this something they're already trying to employ?

Young: Probably half and half. If I had to say, I'm probably two standard deviations ahead of the curve. In part, I'm saying this to be provocative to get people to start thinking about new things. I don't know what's going to happen, but I want to drive a consensus approach. I've gotten a lot of positive feedback intellectually. But the hard part is to put it into practice.

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